Charting a path towards Lanka’s durable success

It is not just because I am from Venezuela that I see Sri Lanka with admiration and envy. The island has made more progress in human development than any other in South Asia. It has reduced poverty in a pretty dramatic way. It has many reasons to be proud of its achievements. But anything that is worth doing, is worth doing better. The Center for International Development at Harvard University is collaborating with the Government of Sri Lanka to work on a strategy to make progress faster, more sustainable and more inclusive.

In the process of coming up with ideas on a better path forward, we carried out, with government officials and the Millennium Challenge Corporation, a growth diagnostic. The gist behind this methodology is to identify the binding constraints that are holding progress back.

Typically, most countries can improve on many areas, but there are bottlenecks in some areas that hold back progress in a general and systemic way, while others are either nice to have or even potentially bad to have at present, because it would worsen other more pressing constraints.

In going through the list of possible constraints and their tale-telling symptoms of their “bindingness”, two things caught my attention: the fiscal situation and the weakness of the export sector. Taxes as a share of GDP had been falling like a stone – from about 18% of GDP in 1995 to about 10% 20 years later.

The public debt to GDP ratio and the interest rate on that debt is uncomfortably high and access to additional financing is precarious. That is why I felt it was really opportune for the government to quickly negotiate a support programme with the International Monetary Fund.

This programme is correctly focused on raising the ability of the state to raise tax revenue, so that it can have the resources with which to accompany the growth of the economy and prevent fiscal weakness from threatening macro stability. Significant progress was made in 2016.

New products

The second problem is the weakness of the export sector. Sri Lanka’s overall economy has grown much faster than the export sector. As a consequence, the ratio of export of goods and services to GDP has declined from 39% to 21 % between 2000 and 2014, the only country in the region where this ratio has declined. At the core of this weak performance is the lack of innovation on the export basket.

This basket is still dominated by tea, rubber and garments, when other countries in the region moved into electronics, machinery and chemicals. To put some numbers into this picture, China, Thailand and Vietnam introduced, respectively, 76, 70 and 48 product lines since 2000. These product lines generated 245, 326 and 545 additional dollars per capita in export revenue. By contrast, Sri Lanka only introduced 7 product lines that represented only 5 dollars per capita in additional revenue.

Moving into new products is always difficult because you cannot make things you do not know how to do and you typically do not know how to do the things you do not make.

This chicken and egg problem is often resolved through contact with people and organisations who already know how to do those things, just not in your country. These sources are immigrants, diasporas and foreign direct investment. On these fronts, we can compare and contrast Sri Lanka to other countries.

We all know that back in 1965, Lee Kwan Yew spoke admiringly of Sri Lanka. Since then, the bulk of the flow of admiration has changed directions. Singapore is now some 7 times richer than Sri Lanka in per capita terms. Part of the secret of Singapore comes from the fact that about 40% of its population is foreign born: two out of every five. In Sri Lanka, the equivalent number is just 1.6% and of these, 99% are people born in India. This means that non-Indian foreigners are less than 1 in 6,000.

China benefited enormously from diasporas in Taiwan, Hong Kong and elsewhere that could bring to the mainland business ideas that had succeeded elsewhere. India’s Bangalore and Hyderabad have deep connections to the Indian diaspora in Silicon Valley and elsewhere. Sri Lanka, for reasons that we all understand, has had a more troubled relationship with much of its diaspora.

Finally, in the 1995-2015 period, foreign direct investment in Sri Lanka, at 1.1% of GDP has been just a small fraction of that observed in Malaysia (3.3%), Viet Nam (4.9%) and Singapore (21.9%). Moreover, the industries that predominantly attract this foreign investment in Sri Lanka – logistics, financial services and tourism – are growing their exports faster than other areas such as manufacturing.

Traditional exporters

In addition, much of the traditional export industry competes with poorer countries that pay lower wages. These industries pay some of the lowest wages in Sri Lanka. Moreover, as the economy grows and real wages increase, traditional exporters have trouble retaining the labour force they have. As a consequence, they shrink. By contrast as the economy grows, imports go up. The imbalance between booming imports and shrinking exports causes a widening balance of payments deficit that puts a brake on growth. This has lead to repeated balance of payments problems over the past 20 years, as in 2001, 2008 and after 2011.

The solution is to help the economy upgrade its current exports and find new ones. This is a process for which there is no known universal to-do list. It is about exploring the set of opportunities and identifying the obstacles that prevent them from happening. It requires engaging with the people at home and abroad that could engage in these activities and with the myriad of public sector entities that need to coordinate to help remove the identified obstacles.

With this in mind, my colleagues at the Center for International Development, led by Professor Matt Andrews, have worked with 5 inter-agency teams that bring experts together from the Board of Investment, Export Development Board, Tourism Development Authority, and Ministry of Development Strategies and International Trade (with connections to the Prime Minister’s Office, Ministry of Foreign Affairs, and Department of Commerce, among others).

These teams are leading the process of promoting emerging exports, targeting new non-existent industries, identifying and engaging with potential new investors, fixing the investment climate for these new emerging industries and figuring out how to make new tourist destinations, such as Kuchchaveli, succeed. In addition, Prof. Robert Lawrence is coordinating with a team that is working with Sri Lankan authorities on the trade negotiation strategies with India, China and Singapore in order to open new markets for old and new exports alike.

Sri Lankan civil service

In this work, we have been very positively surprised by the quality, energy and commitment of the Sri Lankan civil service. I think the teams are producing great work.

As we move forward, the implementation challenge is going to be related to streamlining the decision-making and execution capacity in a government with 51 ministries, 47 Cabinet ministers, 20 state ministers and 25 deputy ministers. The country needs to have an authorization and monitoring process that ensures cooperation, at the technical and political level, across ministries.

The activities I have discussed are but a fraction of the issues that the country must deal with. But success in these areas will accelerate progress, help create more jobs, raise worker incomes and increase tax revenues so that the country can have the resources with which to tackle other challenges. I hope I am right. In any case, I am rooting for Sri Lanka’s success.

(The writer is a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is Director of the Center for International Development (CID) at Harvard University and a professor of economics at the Harvard Kennedy School. He directs CID’s Sri Lanka project.)